Marsh McLennan released its earnings yesterday, revealing an EPS of $2.89, beating estimates by 14%. In addition, the broker announced 9% organic revenue growth, extending its multi-year boom.
As would be expected, the tone of the conference call was positive, and stock was up 2% by the end of the day.
One interesting detail from the call was management noted that while pricing is an element in the company’s success, less than half of Marsh McLennan’s revenue is exposed to P&C pricing.
This brings up an important point. We have often mentioned broking is the first derivative of the P&C industry. If insurers are up 20% across the board, we would expect some bump to broker revenue. However, as these franchises have become more diversified through the type of entity owned – the business mix, geography, or what have you – their respective head- and tail-winds begin to differ.
This note dives into this phenomenon, and how it has driven historic results.
The business mix of each franchise determines the level of pricing influence on broker results
As we mentioned above, Marsh McLennan commented during its call that less than 50% of its business is sensitive to industry pricing trends. This is a noteworthy point, and one we may lose sight of when we focus on the broking aspect.
Marsh McLennan has a huge consulting business, which will dampen any insurance swing in either direction. AJ Gallagher and Brown & Brown, on the other hand, are largely concentrated in actual broking operations.
The chart below shows a proxy for these concentrations, by breaking out the portions of the revenue that are “pricing sensitive” – directly touching the P&C space – in blue, while other portions such as consulting are purple.
It is clear there is a wide gap as far as the distribution of these businesses goes, so pricing changes will affect carriers disproportionately. Please note that this is not an exact proxy, as companies may have fee business, or include non-broking portions of their business in the broking segment accounting.
This explains why we don’t see rate jumps directly corresponding to bumps in revenue and why the recent pricing wind-down has not led to dwindling growth for Marsh McLennan. However, since this business mix is so different across the board, we can’t say that other names will not be more affected by the lower rates this quarter.
Pricing does affect the brokerage segments, but is influenced by client segment concentration
While the mix of the overall business at each franchise will determine to what extent pricing is influencing numbers, the chunk of each company that is a brokerage will be highly affected by pricing and cyclicality.
On the Marsh McLennan call, management pointed out that middle market pricing is up more than large accounts and is typically less cyclical. This is an interesting dynamic that can sometimes become overshadowed by lines of business discussions.
To investigate, we have taken our usual organic revenue growth chart and overlaid two CIAB index lines: one showing the middle market growth, and one showing large account growth over time. The data is divided into two charts for readability and based very loosely on client focus.
Notice the interplay between the CIAB lines for different segments and the insurer growths. It is also interesting to note that small account growth shows almost no shift over time, growing at a steady 6%-7%, while the others rise and fall.
It is easy to see how this difference would change the dynamics of pricing based on the client focus of each broker, even within the broking-only segments. Aon, for example, has a much higher concentration in large accounts than AJ Gallagher or Brown & Brown, two companies we saw with double-digit growth at various points in the recent past, compared to Aon’s single digits.
Taking this a step further, we’d like to understand the drivers. The charts below show something interesting. We can see that employment numbers for the middle market began to take off in Q1 2021, and were significantly outpacing both large and small business employment growth within two quarters.
This would indicate at least two growth drivers for middle market brokers, one in the underlying implication that there is simply more business in the space, and second that the exposure for their clients is greater, leading to greater commission.
We would also point out that the projection shows another 10% growth in the coming quarter, as large corporate has headed to 0%, meaning we may just be seeing the beginning of this trend.
Geographic mix helps to drive numbers for those with a global footprint
One additional driver we have been seeing for several quarters is very high growth internationally. While these numbers, well into the teens at times, were to be expected on smaller revenue numbers such as those in the international buckets, they still contribute a boost to the overall performance for companies with an international footprint.
However, if we look at some of these numbers in the current reporting period compared to the previous year, we see a bit of a shift. While management cited strong international growth on the call (and it was strong), it was just one year ago that other geographies were in the low double digits, while the US was at 7%. This year, the locations are mostly neck and neck.
To explain this, we looked at the GDP growth for the past few years in the US compared with internationally. This explains some of what we have seen in results, with previous growth in Latin America slowing. It also indicates further slowdown for 2024, meaning any international boost from previous years should be somewhat muted this year.
We would, however, caution that GDP is merely a proxy and only represents the passive change that one might expect for a broker, and any targeted initiatives in these regions would cause a major variation from this trend.
In summary, Marsh McLennan’s strong performance, while tied in part to pricing strength, was also driven by its particular business mix and client focus, so any read-through to the space is somewhat limited.
While we can conclude that middle market segments for brokers should continue to get a boost, it is unclear how larger account growth and other factors will play out for competitors. As some brokers’ performance is more heavily intertwined with pricing movement, we expect to see some names showing a slowdown this quarter and the near future.
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